How to resolve the current account crisis?

Bangladesh observed a prohibitive current account deficit of $17.1 billion in the last fiscal year of 2021-22. It, however, averaged $0.32 billion annually over the 12-year period from 2009 to 2021.  

The ballooning current account deficit is causing a fast depletion of foreign exchange reserves and a crisis in the foreign exchange market. For over 12 months, the Bangladesh Bank resorted to selling foreign exchange reserves in order to support an overvalued taka against the US dollar. The policy was untenable and caused a fast depletion of forex reserves.

The central bank has, therefore, resolved to quit its decade-long policy to peg the taka to the US dollar in the range of Tk 80 to Tk 85. The new peg is now Tk 94.7 and it may go further downward.

However, the US dollar is reportedly trading at more than Tk 100 per unit in the kerb market. The widening gap between the official exchange rate and the market rate is gripping both policy-makers and businesses with uncertainty and mounting exchange risk.

Critics of the government are drawing an improper equivalence between Bangladesh and other South Asian neighbours such as Sri Lanka and Pakistan with respect to the issue of debt sustainability

The policy-makers, after enjoying a decade of stability in the exchange rate and external accounts, are suddenly embroiled in a crisis scenario. Their challenge is to reset monetary and exchange rate policies so that the widening current account imbalance doesn't evolve into a full-blown currency crisis. In order to do so, we need to look at the underlying drivers, both domestic and international, of the ballooning current account deficit.

First, global prices of coal, oil, gas and other primary commodities, including food grains, have more than doubled over the last 12 months and this resulted in an unprecedented rise in the cost, insurance and freight value of those imports. The reopening of the global economy after the coronavirus pandemic, the breakdown of global supply chains and the Russian invasion of Ukraine were to blame for the surge in commodity and energy prices across the globe.

Second, Bangladesh's economy, after the long 18 months of lockdowns with significantly reduced activity, reopened in the middle of 2021. It implies that households, the government and firms returned to the normal way of consumption and investments. That is, aggregate demand, which was decimated by the pandemic, rapidly expanded and the demand curve shifted to the right.

The massive fiscal and monetary stimulus, which the government of Prime Minister Sheikh Hasina rolled out in March 2020, surely contributed to further acceleration of the aggregate demand. In fact, private sector credit growth accelerated from 10 per cent in 2020-21 to 15 per cent in 2021-22. For countries like Bangladesh, this implies further escalation in both the volume and value of imports of raw materials, intermediate inputs and final goods.

Third, the role of government spending for large infrastructure projects and an overvalued exchange rate of the taka until the end of 2021 is a critical issue for the dynamics of current account deficits. It deserves a nuanced explanation.

The government initiated many mega projects in the areas of energy, connectivity, ports and telecommunication infrastructures.
The government spending, therefore, accelerated and a large part of it was leading to a growth in imports of capital goods over time. But the same is also believed to be stimulating national economic growth and employment in the long term.

The issue of time and cost-overruns is a perennial issue in the developing world. Bangladesh is no exception. Rather, it observed persistent improvement in project management. The successful completion of Padma Multipurpose Bridge, Dhaka-Chattogram highways and the like bear testimony to this claim. A long-term capacity building of the government is evident in this area.

The prohibitive current account deficits in 2021-22 are an outcome of all these factors. At the heart of this imbalance lies widening dissaving by both the government and the private sector. While public dissaving is the excess of the government spending over its revenue, the dissaving of the private sector is the excess of private sector investments over gross domestic savings. The policymaker's job is to bring about sustained improvements to both fronts.

I will offer a mix of public policies to achieve this end.

First, government spending must decrease. Every element of government expenditure shall require a critical review.

The government's spending on unproductive activities is better eliminated or substantially curtailed and the expenditure for new or early-stage large infrastructures is better deferred for an indefinite period until the economy navigates into sustainability.

The spending on social safety nets shall also need to be revisited and made more efficient. The government is in fact in the process of eliminating or minimising spending of lesser importance.

Second, Bangladesh lived with an overvalued exchange rate for years until 2021. In an environment where a developing country experiences persistent inflation differentials with respect to the rest of the world and more so against the cohort of low-inflationary advanced economies, a de facto fixed exchange rate will result in a persistent real appreciation.

The extent of the real appreciation for Bangladesh is large but varies across countries. The central bank shall need to orchestrate a gradual devaluation of the local currency.

A 15-per cent nominal devaluation has already happened over the last six months. The exchange premium in the open market is an indication that the central bank will likely permit a further devaluation.

A currency depreciation itself will cause the private sector dissaving to improve over time. However, it may be coupled with some fiscal policy reforms. For example, a reduced corporate tax rate will stimulate foreign capital inflow and encourage more capital expenditures by local corporations. Bangladesh is also offering a window of reporting unexplained income or wealth for non-resident Bangladeshis provided that they pay a one-time tax at reduced rates. But the goal should be the repatriation of capital into the country.

Third, tax authorities may revise tariffs and non-tariff regulations discouraging imports of cars and luxury goods. A currency depreciation itself will prove discouraging for this kind of imports. A new tariff in addition and some non-tariff barriers will further diminish their demand. On the other hand, a reduction in tariffs for food and energy imports will mitigate cost-pushed inflationary pressures to some extent.

But the litmus test for the central bank will be to guide exporters to repatriate their foreign exchange in real-time. In times of large currency devaluation, exporters and domestic residents will form an expectation of further devaluation of the local currency and choose dollarisation of their financial assets. This downward expectation revision is an unmitigated sin and it can bind policy-makers in a spiral of currency depreciation without significant improvement in external account imbalance. Bangladesh Bank must focus on managing this speculative behaviour of economic agents.

Fourth, a monetary tightening, and so raising interest rate, is now imperative in order to depress components of aggregate demand and bring down inflation. Household demand for consumption, corporate demand for investments and also government spending shall diminish as interest rates keep rising.

In an environment of soaring inflation, a slowdown of aggregate demand is rightly the policy objective. Bangladesh Bank may move faster in this direction. A relative economic contraction is now desirable for reducing inflation and improving the current account imbalance.

A very unfavourable monetary development is happening across advanced economies. Advanced economies, too, are invariably pursuing monetary tightening and raising interest rates after a decade of low inflation and (near) zero interest rate policies. It is causing a reversal of global capital flow, putting many developing and emerging market economies at the cliff.

This reversal is causing a fast depletion of their foreign exchange reserves, liquidity crises in the financial system, rising interest rates, and currency crises across the developing world. A global capital reversal will cause financial and stock market shocks.

Bangladesh, too, is now embroiled in this unfavourable global development. Many developing countries, which were hitherto resilient, are now hugely constrained by dwindling foreign exchange reserves and rapidly depreciating their currencies.

Finally, critics of the government are drawing an improper equivalence between Bangladesh and other South Asian neighbours such as Sri Lanka and Pakistan with respect to the issue of debt sustainability.

The external debt stock of the country was reported to be $93.2 billion as of May 2022. Of this, the external indebtedness of the public sector was $68.3 billion. It is 19.25 per cent of GDP and 81.4 per cent of it was long-term in nature.

The external indebtedness of the government declined from 42 per cent of GDP in 1991 to less than 20 per cent in 2022. The total debt servicing is about 6 per cent of current account receipts (including exports of goods and services and primary income) and 0.82 per cent of gross national income.

An unfavourable development happened in the area of external indebtedness by the private sector. This volume rapidly increased from $18.6 billion in June 2021 to $25 billion in May 2022. This is an area of monitoring and control by the central bank as 68 per cent of this mounting private sector indebtedness is of short-term credit. A disproportionate share of this private sector external debt is mostly suppliers' credit and is considered to be opaque.

The author is a commissioner of the Bangladesh Securities and Exchange Commission. Views are personal.